Updating the Mortgage Finance Bubble

Equities were basically listless, with small declines across most indices.
For the week, the Dow dipped 0.4% and the S&P500 declined 0.9%. The Transports
lost 0.8% and the Utilities declined 0.4%. The Morgan Stanley Cyclical index
dropped 2%, while the Morgan Stanley Consumer index was down 0.6%. The broader
market was down, with the small cap Russell 2000 declining 1% and the S&P400
Mid-cap index losing 1.2%. The NASDAQ100 fell 1.1%, and the Morgan Stanley
High Tech index dipped 0.6%. The Semiconductors were about unchanged, while
the NASDAQ Telecommunications index was down 0.5%. The Biotechs slipped 0.3%.
The financials were mixed. The Broker/Dealers were down 0.7%, while the Banks
added 0.8%. With bullion down $9.90, the HUI Gold index fell 4%.

Freddie Mac posted 30-year fixed mortgage rates dropped 9 basis points to
5.80%, a three-week low. Rates were one basis point below the year ago level.
Fifteen-year fixed mortgage rates fell 7 basis points to 5.40%. One-year adjustable
rates added one basis point to 4.58%, up 34 basis points in seven weeks and
57 basis points higher than a year earlier. The Mortgage Bankers Association
Purchase Applications Index was about unchanged. Purchase applications were
about 7% ahead of the year ago level, with dollar volume up almost 19%. Refi
applications rose 5%. The average new Purchase mortgage dipped slightly to
$243,000, while the average ARM jumped to a record $358,800. The percentage
of ARMs declined to 28.9% of total applications.

International reserve assets (excluding gold) - as accumulated by Bloomberg's
Alex Tanzi - were up $601 billion, or 18.2%, over the past 12 months to $3.908
Trillion. Japan's reserves, the world's largest, were up $21.62 billion, or
2.7%, over the past year to $821.68 billion.

Currency Watch:

The dollar index rallied almost 2% this week. On the upside, the Jamaica dollar
and Israeli shekel gained 0.8%. On the downside, the Brazilian real dropped
3.1%, the Norwegian krone 3.3%, South African rand 2.9%, and Swedish krona
declined 2.9%.

August 17 - World Bank: "Fueled by strong external trade, real gross domestic
product (GDP) in China grew a stronger than expected 9.5 percent in the first
half of 2005, according to the August issue of the China Quarterly Update.
With merchandise exports up by 33 percent in the first half (in US$ terms),
and by 29 percent in July, China reached a trade surplus of US$50 billion in
the first 7 months. Imports, meanwhile, decelerated significantly from 33 percent
in 2004 to 14 percent in the first half."

August 16 - Bloomberg (Nerys Avery and Rob Delaney): "China's fixed-asset
investment grew 27.7 percent in July, led by spending on oil refineries and
coal mines to ease energy shortages. For the first seven months, investment
in the nation's towns and cities rose 27.2 percent from a year earlier to 3.46
trillion yuan ($427 billion)..."

August 15 - Bloomberg (Nerys Avery): "China's industrial production rose 16.1
percent in July as companies including General Motors Corp. and Huaneng Power
International Inc. boosted output to meet rising demand in the world's fastest-growing
major economy."

August 16 - XFN: "China's major ports handled 2.2 bln tons of cargo in the
first seven months this year, up 18.7% year-on-year, the Ministry of Communications
said... From January to July, container throughput at the ports increased 24.2%
from a year earlier..."

August 17 - Bloomberg (Jianguo Jiang): "Growth in China's property prices
slowed in the first seven months of the year from the first half as unsold
real estate space rose, according to the National Bureau of Statistics. Prices
gained an average 9.7 percent from a year earlier..."

Asia Boom Watch:

August 16 - Bloomberg (Lily Nonomiya): "Morgan Stanley Japan Ltd. raised its
growth estimate for Japan's economy this fiscal year... Morgan Stanley raised
its forecast for economic growth for the year ending March 31, 2006 to 2.5
percent, from an earlier forecast of 1.6 percent..."

August 15 - Bloomberg (Cherian Thomas): "India's economy will grow 7 percent
in the current financial year ending March 31, Prime Minister Manmohan Singh
said. 'This year we will achieve an economic growth of 7 percent,' Singh said
on the occasion of India's 59th Independence Day. 'If we keep
this pace, in 10 years we will be able to wipe out poverty. This is no longer
a dream but is a possibility now.'"

August 16 - Bloomberg (William Sim): "South Korea's economy will expand at
a potential annual growth rate of 5 percent next year after growing between
4 percent and 5 percent in the second half of this year, Finance Minister Han
Duck Soo said."

August 18 - Bloomberg (Theresa Tang and James Peng): "Taiwan's economic growth
rebounded from a two-year low in the past quarter and is forecast to gather
pace as companies and consumers increase spending. Gross domestic product rose
3 percent from a year earlier after climbing 2.5 percent in the first quarter..."

August 17 - Bloomberg (Sara Webb): "Singapore's exports in July rose at nearly
three times the pace expected by economists as companies shipped more computer
chips and pharmaceuticals. Non-oil domestic exports rose a seasonally adjusted
12 percent from June... Exports in July expanded at the fastest pace in 2 1/2
years."

August 15 - Bloomberg (Sara Webb): "Singapore's retail sales rose 9.4 percent
in June from a year earlier, exceeding economists' expectations, as Singaporeans
bought more cars and tourists boosted spending on clothes, watches and jewelry."

August 17 - Bloomberg (Beth Jinks and Laurent Malespine): "Thailand's economy,
Southeast Asia's second-largest, expanded less than 4 percent in the second
quarter... The $163 billion economy is slowing as higher oil prices increase
the cost of imports, dent consumer confidence and push up production costs..."

Unbalanced Global Economy Watch:

August 18 - Bloomberg (Simon Kennedy): "The inflation rate in the dozen nations
sharing the euro rose to a seven-month high in July, exceeding the European
Central Bank's limit as oil prices jumped to record levels. Consumer prices
rose 2.2 percent from a year ago..."

August 18 - Bloomberg (Sam Fleming): "U.K. mortgage lending in July was the
weakest in more than 3 1/2 years, as households refrained from taking out debt
in anticipation the Bank of England would lower interest rates the following
month."

August 16 - Reuters (Elif Kaban): "Lured by booming oil prices and friendly
Kremlin ties, Western banks want to extend Russia the largest loans in its
history, brushing aside fears of bad debts, the ghosts of fallen YUKOS and
high levels of borrowing. The biggest loans include $7 billion to fund
Russia's purchase of a 10.7 percent stake in gas monopoly Gazprom, $2 billion
for state oil firm Rosneft and up to $10 billion for Gazprom to buy oil firm
Sibneft. One group of banks even temporarily waived covenants protecting their
rights in a dispute over a defaulted loan with Rosneft so they could lend it
even more money, bankers said."

August 17 - Bloomberg (Torrey Clark and Michael Teagarden): "Russia attracted
31% more foreign direct investment in the first half than a year ago,
as consumer goods producers such as Coca-Cola Co. and H.J. Heinz Co. bought
Russian competitors amid a boom in spending. Foreign direct investment advanced
to $4.49 billion in the first half, from $3.4 billion a year ago..."

Latin America Watch:

August 18 - Bloomberg (Guillermo Parra-Bernal and Carlos Caminada): "Brazil's
current account surplus rose to a record in July, led by a surge in exports.
The surplus in the current account, the broadest measure of trade in goods
and services, widened to $2.59 billion in July from $1.25 billion in June and
$1.8 billion a year earlier... The surplus in July was the largest for any
month since Jan. 1980, when the government began keeping records..."

August 16 - Bloomberg (Guillermo Parra-Bernal): "Brazilian retail sales rose
in June at the fastest pace in three months, suggesting consumer spending on
home appliances, cars and furniture is holding up after nine central bank interest-rate
increases. Sales, as measured by units sold, rose 5.3 percent from a year ago..."

August 18 - Bloomberg (David Papadopoulos): "Venezuela's economic expansion
quickened in the second quarter, led by a surge in manufacturing and construction.
Gross domestic product grew 11.1 percent in the April-to-June period from a
year ago, following growth of 7.5 percent in the first quarter..."

Bubble Economy Watch:

August 18 - Bloomberg (Kathleen M. Howley): "Fannie Mae...said U.S. sales
of existing single-family houses will top 7 million for the first time ever
in 2005 while prices rise by the most in a quarter century as low interest
rates fuel demand. Sales will reach 7.03 million, up 3.6 percent from 2004's
record 6.78 million transactions, David Berson, Fannie Mae's chief economist,
said in a forecast in Washington... A month ago, he predicted 6.79 million
sales. Home prices will rise 11 percent, Berson said, the biggest jump since
a 12 percent gain in 1980."

August 17 - New York Times (Robert Johnson): "Even in this gaudy city a building
painted black and pink stands out. It needs to, because the one-floor structure
at the corner of the Strip and Sahara Avenue is a condominium sales center
in a metropolis where more than 100 new high-rise residences are in the
works. The black-and-pink exterior was designed by the woman who is the
namesake of the planned condominium... 'It just screams Ivana.' That would
be Ivana Trump... Although the condo itself, scheduled for groundbreaking in
mid-2006 and opening 30 months later, will be a relatively sedate silver color,
it will command attention as the tallest skyscraper in Las Vegas. [The developer]
estimates construction costs at $500 million... The Las Vegas condo market
is heating up fast. Some 6,000 units are under construction, compared with
about 300 in early 2004, according to Gunther Gedsl, a high-rise analyst...
Some 6,000 units are in the preconstruction sales phase, he said, versus 4,000
as 2004 began... Mr. Gedsl estimated that 12,000 condo units had entered the
'idea stage' within the last 18 months."

California Bubble Watch:

August 18 - Reuters (Jim Christie): "Home-ownership in California has increased
to a level not seen since 1960 but it is coming at a high cost and risk for
home buyers, according to a study... To keep up with soaring home prices, Californians
are setting aside a dangerously large share of income for house payments and
taking on risky mortgages, according to the Public Policy Institute of California.
It found 52 percent of Californians who bought a home in the last two years
spend more than 30 percent of their total income on housing and 20 percent
of recent home buyers spend more than half of their income on housing."

Speculator Watch:

August 16 - Financial Times (Richard Beales): "The global market for collateralised
debt obligations - complex repackaged pools of bonds, loans and other debt-related
instruments - could be dramatically higher than most investment banks have
indicated, an independent industry consultant has estimated. In particular,
if all the so-called "synthetic" products - or derivatives-related deals -
are included, the total market could reach $800bn or more this year, according
to Janet Tavakoli, an industry consultant. But the market remains opaque, with
no standard way of measuring its size and many CDO arrangers reluctant to reveal
information about bespoke transactions conducted privately with investors."

August 17 - Financial Times (Deborah Brewster): "Christie's, the art auction
house, had record sales in the first half of this year as the art market was
buoyed by a convergence of old and new - US hedge fund and property moguls
buying contemporary art, and Russian and Chinese buyers reclaiming their artistic
heritage. Sales at Christie's, which is owned by François Pinault, were
$1.65bn in the six months to June - a third higher than last year. It sold
178 works of art for more than $1m, compared with 132 during the same period
last year. [Sotheby's] said it expected 'the current buoyancy in the international
art market to continue'. Matthew Weigman, a Sotheby's spokesman, said: 'What
we are seeing is a rush of new buyers from Russia and China who are buying
back their heritage.' The auction house's Hong Kong sale this year reaped $81m,
which would have been unheard of just a few years ago, said Mr Weigman. Last
year's Hong Kong sale reached $57m."

August 16 Financial Times (James Altucher): "The latest twist in the growing
secondary market for life insurance policies is an innovative asset-backed
lending strategy called life insurance premium finance. There is a class of
seniors who would like life insurance policies but acquiring a policy at that
age can mean expensive premiums. However, because the secondary market in life
insurance policies establishes a market and means for valuing policies it is
possible for seniors to borrow the money to pay for the premiums and use the
policy itself as the asset backing the loan. Why would people want to do this?
Most of their assets could be illiquid or tied up in other investments... Why
would investors want to lend? Lenders would typically receive the 10-15 per
cent interest on the loan; lenders would be provided with an investment opportunity
outside of traditional asset classes... Investors range from hedge funds to
banks to endowments and all use life settlements not only as a source of returns
but also as a way to diversify away from the traditional asset classes of equities,
bonds, commodities."

Mortgage Finance Bubble Watch:

August 15 - National Association of Realtors: "Total existing-home sales,
which include single-family and condos, were at the highest pace on record
in the second quarter, with 42 states showing higher sales in comparison
with a year earlier... NAR's latest report on total existing-home sales shows
that the national seasonally adjusted annual rate was 7.22 million units
in the second quarter, up 4.6 percent from the previous record of 6.90 million
in the second quarter of 2004."

August 16 - Bloomberg: "United States home prices surged 13.6 percent in
the second quarter, the fastest pace in more than a quarter of a century,
as a decline in interest rates fueled record sales. The median price of an
existing single-family home rose to $208,500 from $183,500 a year earlier,
the National Association of Realtors said...It was the biggest jump since
a 15.3 percent gain in the third quarter of 1979."

July Housing Starts were reported at a stronger-than-expected (and robust)
2.042 million pace, about 3% above the year ago level. Building Permits were
a much stronger-than-expected 2.167 million pace, the strongest in more than
30 years. Starts were up 8.2% from a year earlier and up 32% from July 2001.

August 16 - American Banker (Damian Paletta): "Fresh evidence emerged...that
lenders are piling into untested mortgage products and that regulators are
increasingly worried about it. More than half of the respondents to the
[Fed's] quarterly survey of senior loan officers said their share of interest-only
and other nontraditional mortgage products is substantially or moderately higher
than a year before. Nearly a third said that such products make up 16%
to 50% of their dollar volume of residential mortgages - substantially more
than previously estimated. The survey report also said mortgage demand
was up despite recent interest rate hikes and noted looser underwriting standards
for commercial and industrial loans..."

August 19 - Inside Mortgage Finance: "According to Inside Alternative Mortgages,
a new affiliate newsletter, Alt A mortgage activity has continued to climb
to record levels through the midway point in 2005, fueled by burgeoning volume
in interest-only mortgages, negative amortization ARMs and loans processed
with 'stated' documentation."

Golden West Financial reported a somewhat slower July. Originations dipped
to $4.5 billion, down from June's $4.8 billion. Loan growth slowed to 13% annualized,
although y-o-y Loans were still up 24% to $113.9 billion. On the Liability
side, FHLB Borrowings were up 20% y-o-y to $36.3 billion, with Deposits up
19% to $59.4 billion.

The Bond Market Association (2nd) Quarter Research Quarterly:

"...U.S. bond issuance rose slightly in the second quarter, reaching $1.36
trillion, a 1.6 percent increase over the first quarter. Mortgage related securities,
U.S. Treasuries and corporate bonds all fell during the quarter but municipal
bond issuance was higher and the volume of asset-backed securities increased
sharply, rising 19.2 percent over the first quarter and nearly 40 percent more
than the second quarter last year. For the first six months of the year,
ABS issuance totaled $555.6 billion, a 35.5 percent increase..."

"Overall bond market issuance for the first half of the year...remains 7.8
percent below the same period last year primarily because of a sharp decline
in the amount of debt issued by federal agencies, including Fannie Mae and
Freddie Mac... Private label originators picked up some of the slack... Overall,
mortgage-backed issuance rose in the second quarter 5.7 percent but fell 11.7
percent for the full first half of the year..."

"U.S. Treasury and corporate bond issuance was also off for the first six
months of the year. Gross coupon Treasury issuance fell from $427.0 billion
a year ago to $413.5 billion this year, as the economy strengthened and tax
revenues increased... Daily trading volume of Treasury securities by primary
dealers averaged $568.2 billion in the first half, up 13.4%... [from] the same
period a year ago. Issuance of municipal bonds rose during the first half
of the year as well, climbing 7.3 percent to $228.7 billion..."

"Corporate bond issuance declined to $340.8 billion in the first half of the
year, 6.9 percent lower than...a year ago... Considering the ample corporate
cash positions, issuance supply growth will be dependent on such factors as
capital spending and M&A and LBO activity... Investment grade non-convertible
debt issuance declined slightly through the first six month, to $301.3 billion...
New issue volume of non-convertible high-yield debt totaled $39.5 billion through
the first six months, a 32.1 percent decline..."

"The torrid pace of new issue activity in the asset-backed securities (ABS)
market continued in the first half...and it is on pace to surpass the $1
trillion mark by the end of the year. The strong housing market, new
product development, low interest rates, and robust investor demand have
led to a semiannual issuance record of $555.6 billion... Securitization
of home equity loans is by far the biggest piece of the ABS market, accounting
for nearly 40 percent of issuance, and it is showing no sign of slowing
down. Record high home prices have created enormous value for home
owners who are now tapping into it by taking out home equity loans...
Higher auto sales have also contributed to greater ABS issuance..."

"Mortgage-related securities issuance, which included agency and non-agency
pass-throughs and CMOs, increased 5.7 percent in the second quarter to $429.9
billion, compared to... the first quarter (first half issuance of $836.5bn
was down 11.7% from comparable refi-driven 2004)... According to the Mortgage
Bankers Association, mortgage originations increased to an estimated $779 billion
in the second quarter, up from $597 billion in the first quarter... Private
label issuers are able to securitize jumbo mortgages in excess of the conforming
loan limit and are more likely to take on additional exposure from riskier
loans, such as ARMs, sub-prime and Alt-A. Issuance of private-label MBS
increased to $238.7 billion in the first half...up [40%] from $170.4 billion
issued in the first half of 2004."

"The average daily volume of total outstanding repurchase (repo) and reverse
repo agreement contracts totaled $5.47 trillion in the first half of 2005,
an increase of 17.4 percent from the $4.66 trillion from the daily average
outstanding during the same period a year ago. Daily outstanding repo agreements
increased 17.1 percent, to an average of $3.17 trillion... Through the
second quarter of 2005, over $204.2 trillion in repo trades were submitted
by [Clearing Corporation's Government Securities Division], with an average
daily volume of approximately $1.6 trillion (24% above year ago volume)."

"The outstanding volume of money market instruments, including commercial
paper (CP), large time deposits and banker's acceptances, totaled $3.15 trillion...a
4.7% increase from the total at the end of March 2005 (up 19% from one year
ago). CP outstanding totaled $1.51 trillion...an increase of 4% [during
the quarter and up 15% over 12 months]... Financial CP outstanding stood
at $1.38 trillion...5.3 percent higher [for the quarter and up 16% y-o-y]. The
use of CP to finance mortgage pipelines drove much of the financial CP growth."

Updating the Mortgage Finance Bubble:

This is a most fascinating period for analyzing the Mortgage Finance Bubble.
On the one hand, with both home transaction volumes and average prices at all-time
highs, Mortgage Credit growth remains at extreme levels. Fannie's latest forecast
has Mortgage debt expanding by 10.4% this year, this following the doubling
of Mortgage borrowings over the previous seven years. On the other hand, there
is clearly newfound seriousness by bank regulators seeking to stymie the riskiest
bank lending practices. And while home sales remain at record pace, the inventory
of unsold homes is rising. Some of the hottest markets are experiencing a rapid
buildup of houses to be sold. The highflying mortgage REIT and subprime stocks
are coming back to earth, while MBS spreads are quietly widening. Meanwhile,
the media are now all over the housing Bubble story.

If this were a decade ago, I would be forcefully arguing that the top was
in and warning that air would soon be seeping from the Mortgage Finance Bubble.
Such assuredness would stem from my confidence that regulatory restraint would
soon instill caution throughout the banking community, especially in the conspicuously
frothy markets. Credit availability and marketplace liquidity would almost
immediately be impacted, ushering in the downside of the Credit cycle. Today,
the nature of the analysis leaves me less confident. Bankers were supplanted
as the marginal source of housing liquidity by the securities markets and the
leveraged speculating community. The analysis has become much more complex.

It has been highly instructive to observe the markets' and economy's resiliency
to a major energy price "shock." In a different environment, interest rates
would have lurched higher, followed by faltering confidence, retreating asset
markets, and a stagnating economy. Yet, these days market rates largely ignore
surging energy costs, at least until prices really spike and incite notions
of a strapped American consumer. All the same, the dollars the consumer sector
is losing at the pump are small change compared to inflating home equity (combined
with rising incomes). The National Association of Realtors puts second quarter
housing inflation at 13.6% y-o-y, "the fastest pace in more than a quarter
of a century."

I do believe that Credit Bubble "blow-off" liquidity excesses are directly
responsible for buoyant bond and inflating home prices, as well as system resiliency
to sharply higher energy prices. And if today's boom can so readily disregard
spiking energy costs, can markets similarly ignore a little tough talk from
bank regulators? To be sure, market dynamics must remain at the forefront of
Credit Bubble analysis.

As much as the bond market - and perhaps even the Fed - wishes to believe
it, I am skeptical that regulation can be counted upon to rein in mortgage
finance excess. First of all, with recent price gains so enticing and the real
estate mania having taken firm hold, I believe significantly higher rates and
reduced Credit Availability will be required to pierce this historic speculative
Bubble. And, of course, no one - not the Federal Reserve, bank regulators,
bond managers or the markets - has any inclination to see a deflating housing
Bubble. Instead, the hope is that housing markets will gradually slow without
too negative of consequences for the economy or marketplace liquidity. There
are today great expectations that a little regulatory arm twisting will provide
just the right level of measured restraint. If only "measured" was in any manner
Credit Bubble effectual...

I will, until proven otherwise, stick with the framework that it is the Financial
Sphere today driving the Economic Sphere. To this point, economic weakness
has been taken out of the equation by the tenacity of bond market rallies engendered
by any indication of waning growth. Considering these powerful dynamics, serious
analysis must at least contemplate the possibility that similar Credit market
dynamics will significantly influence the nature of the unfolding housing toping
process. A rise in market yields has, over the past two weeks, been interrupted
by perceptions of household and housing vulnerability. Would such a market
reaction, if ongoing, ensure continued excess liquidity, sustaining Bubble
excess and fueling higher home prices?

From the intensity of current marketing efforts, I will surmise that interest-only
and "option ARMs" remain the hot products - in spite of bank regulator hopes
and desires. Do an "option ARM" Google search and there will be a long list
of links including ones to wamuhomeloans.com, interestonly.com, and eloan.com.
Search "interest only mortgage" and a similarly long list will include lendingtree.com
and quickenloans.com. It is Quicken that has so aggressively promoted its SmartChoice "option-ARM" product. "Month
after month, you can choose to pay interest only or the combined interest and
principal. Your monthly mortgage payment can be up to 45% lower than a traditional
mortgage!" A $150,000 mortgage for as little as $578 a month, $200,000 for
$750, or $300,000 for $1,125. And tax advantages! I see nothing in the current
environment that makes such a product less enticing to many borrowers - for
a multitude of reasons.

It is reasonable for analysts, observing rising housing inventory, affordability
issues, somewhat rising mortgage rates, and newfound regulator engagement,
to call for a housing bubble top. From my analytical framework, however, I
would expect to observe some change in (securities) marketplace liquidity and
Credit Availability before venturing a guess that the Mortgage Finance Bubble
is peaking. And based upon the breadth and scope of the mortgage finance infrastructure
that has evolved during this most protracted of booms, I am forced to error
on the side caution when it comes to forecasting The Bubble's demise. And it
is, furthermore, difficult for me to envision how such a Bubble goes out with
a whimper.

Today, we are on pace for an astounding $1 Trillion of 2005 ABS issuance,
a large percentage that is mortgage-related. And, according to a recent article
in The Financial Times, CDO (Collateralized Debt Obligations) issuance could
top $800 billion, again with real estate loans comprising much of the underlying
collateral. Private-label MBS issuance is booming. To this point, the marketplace
has demonstrated an insatiable appetite for mortgage-relate securities and
instruments.

But I am open to suggestion that we may be approaching some type of inflection
point. Will all the media attention begin to spook prospective homebuyers?
The banking industry will surely feel the pressure to somewhat tighten standards
at the margin, although I would expect that the enormous apparatus of non-bank
mortgage brokers, "correspondents," and online lenders will gladly take any
business turned away by traditional bankers (that is, for as long as they can
sell their mortgages for securitization!). And somewhat (near-term marginally)
tighter lending terms and higher short-term interest-rates may, going forward,
tend to limit price gains in the most inflated markets (where "option ARM" borrowers
reside as marketplace price-setters). I don't, however, want to overstate the
momentousness of such developments for the Mortgage Finance Bubble as a whole.
Some restraint at the margin will only slightly reduce total Mortgage debt
growth and somewhat moderate current robust housing inflation.

I can see things initially moving in one of two different directions. The
perception of cooling housing markets and consequent mortgage-related vulnerability
might very well impel some speculator liquidation of riskier MBS and mortgage
instruments, and this could prove a major liquidity inflection point throughout
the marketplace for mortgage finance. The mortgage REITs could falter badly,
and 1994 and '98-style mortgage dislocations could materialize. To this point,
however, there has been only moderate widening of mortgage spreads, although
it appears to have recently somewhat accelerated.

But I think we should also be mindful of an alternative scenario: Heightened
systemic fragility associated with weakening (or the risk of weaker) housing
and MBS markets could incite another decline in Treasury yields. One could
even envisage an environment where increased stress in certain sectors of mortgage
finance (riskier home equity loan ABS and CDOs, and private-label "jumbo" MBS,
for example) might actually - due to sinking Treasury yields - reduce borrowing
costs for more conventional (including 30-year fixed) mortgage loans. Moreover,
an unwinding of Mortgage Carry Trades could, potentially, provoke a destabilizing
Treasury market rally.

I have a difficult time believing that American households are about to all
of the sudden wake up one morning and ponder the possibility that housing prices
aren't destined to rise forever. That would defy the nature of manias. The
system must instead somehow restrict liquidity from eager real estate borrowers,
a development that today does stretch the imagination (with too many livelihoods
depending on the perpetuation of lending excess). Importantly, Mortgage-related
securities and instruments remain the key asset class for a massive (and still
growing!) leveraged speculator community desperate for yield and positive returns.
This facet of the analysis is today more fundamental than any housing metric.

For the massive leveraged speculating community, too much finance is chasing
inflated asset markets and meager risk premiums. Today and going forward, there
is no avoiding the serious dilemma posed by significantly limited opportunities
for acceptable returns. There may have in the past been some legitimacy with
respect to marketplace "arbitrage" opportunities, but no longer. The Massive
Mortgage Carry Trade is a combination Credit spread and the classic borrow-short-lend-long.
But borrowing costs are rising, while thin Credit spreads defy escalating Credit
risk. Nevertheless, the most prominent influence on today's speculating decisions
is the necessity to achieve positive returns. A deteriorating financial backdrop
- in this age of unlimited liquidity - ironically spells only greater speculator
leveraging and risk-taking - as we have witnessed.

On many levels, late-stage Credit Bubble dynamics foment powerful liquidity-creating
and risk-taking behavior, irrespective of deteriorating underlying fundamentals.
This is an essential facet of the analysis of why Monetary Disorder imparts
progressively deleterious effects upon the system pricing mechanism, and why
such Bubbles end inevitably in busts. Today's Credit system does not function
like the banking system of years past - when bank loan officers and Fed open
market operations dictated system liquidity. Can today's securities and speculator-driven
marketplace/Credit system effectively regulate Credit creation and marketplace
liquidity? It certainly does not appear that it can. While a spike in yields
would abruptly and perhaps radically change liquidity and speculative dynamics,
is there some market rate below the crisis point that would stabilize Mortgage
Credit excess without bursting the Bubble? I doubt it's possible.

The bottom line, with regard to Updating the Mortgage Finance Bubble, is that
interest rates and marketplace liquidity remain highly accommodative to ongoing
dangerous excess. The worst-case scenario continues to play out. As such, the
fluid environment beckons for the attentive monitoring of the interplay between
the Mortgage Finance Bubble and the Leverage Speculating Bubble.